Can U.S. Shale Survive The Oil Price War?

On Friday, the oil market's worst fears came true: OPEC+ failed to agree on how to deal with the coronavirus' effect on oil demand, sending oil prices plunging. But with the start of the new week came new horrors for the oil market, with Russia and Saudi Arabia waging a full-on oil price war as both prepare to increase oil production and flood the market.

And now, the market is left wondering which mega oil producer will cry uncle first: Saudi Arabia or Russia. But a third-wheel in this oiltastrophe is none other than US shale, and both Russia and Saudi Arabia are likely rooting for the death of America's oil production, which undermined OPEC+'s best efforts to manage the market thus far.

Amid this catastrophic development that saw an ugly end to the Saudi Arabia and Russia relationship, analysts and banks are scrambling to redo their oil price forecasts yet again, with the coronavirus still breathing down their necks, and with the two increasing oil production at a time when oil demand is expected to contract in 2020 for the first time since 2009.

And what the early analysts are predicting is that oil prices will fall-and fall hard.

And it's already begun.

Spot prices for WTI crude had fallen to $30.23-a price level not seen in years. Brent crude was trading down to $34.36

Is this price sustainable for oil producers?

Russia, at least, says yes.

Russia's Finance Ministry on Monday declared that Russia could sustain $25-$30 oil for at least six-and as many as ten-years.

But some analysts say this is magical thinking, and that a more realistic timeframe for weathering a super low oil price environment can be measured in months, not years. Related: Offshore Wind To See $200+ Billion Expansion By 2025

Regardless, it is not important that Russia be able to withstand $25 for ten years. It only needs to hold out longer than now-rival Saudi Arabia, and that's a likely scenario.

Russia's eagerness to test that theory, to some, may seem rather cocksure, but there is likely a method behind their seeming madness.

If Russia and Saudi Arabia had indeed agreed to even more of a production cut, what then of US shale? Russia has long argued that further production cuts are merely playing into the hands of US shale; the more production OPEC+ members cut, the more room US shale is given to ramp up production. An oil cartel's strength to manipulate markets, after all, is directly tied to the percentage of global production they wield.

And the United States produces more oil than either Saudi Arabia or Russia.  

"We, yielding our own markets, remove cheap Arab and Russian oil from them to clear a place for expensive American shale. And to ensure the efficiency of its production. Our volumes are simply replaced by the volumes of our competitors. This is masochism," Rosneft spokesman Mikhail Leontiev told Russia's Ria Novosti news agency over the weekend.

There is no real solution to this predicament that OPEC and its allies have put themselves in. Their market manipulation efforts have managed to hold prices up for a time, but it has also opened the door for US shale to turn on the taps-and US producers were all too willing to take advantage.

Now, Russia is ready to push back US shale with low oil prices that Russia hopes will knock back America's zealous energy independence campaign.

The Case For Saudi Arabia

Like Russia, Saudi Arabia claims low breakeven levels for oil too. But these figures are not audited, and not verifiable. The Kingdom has said in the past that their straight-up breakeven is $10 per barrel. But that's not the whole monetary story. Aramco struggled to generate a profit even when oil was hovering around $45 per barrel back in 2016, reporting a free cash flow of just $2 billion.

The price at which Saudi Arabia's budget breaks even-the fiscal breakeven--is more like $83.60 per barrel-nearly twice the level that Russia needs, and well below what oil is trading at today. Related: Climate Change Goals May Not Go Far Enough

It seems highly unlikely that Saudi Arabia would be able to outlast Russia in this game of chicken, but it might be banking on at least outlasting US shale.

But such a strategy from The Kingdom may bring back painful memories for Russia (and the United States) of 1986, when Saudi Arabia, frustrated with OPEC members who kept overproducing when the market wasn't hungry for it, employed a strategy of willfully overproducing itself, undercutting oil prices-a strategy that sank oil to just $10 a barrel.  

The Mighty US Shale Takes on Saudi Arabia and Russia

US shale producers are a whole different beast from Saudi Arabia and Russia, and US shale producers won't go down without a fight.  

Not state-owned, each US shale producer can act independently. But they also are not officially subsidized and therefore must bend to the will of the markets. That is, unless banks are willing to extend cash to US producers regardless of production companies' viability in a low-price environment.

Thus far, US shale has outlasted what even most analysts thought-certainly longer than what Saudi Arabia thought, when it tried to drown US shale in oil just a few years back before it failed miserably and decided to, with the help of OPEC, cut production instead.

Analysts are predicting that many US oil companies will face tough times if oil prices continue down its current path. US shale has long been accused of being debt-laden, and breakevens for US drillers are somewhere in the high $40s per barrel.

But analysts-and OPEC--have made that mistake before, at their peril. US shale has lapped up many of the barrels that OPEC and Russia have ceded, whether propped up by debt or not, and they very well may do so again, leaving Russia and Saudi Arabia to fight over who will be the biggest loser.

By Julianne Geiger for Oilprice.com

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